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Gold bears set sights on critical support level into Fed week

Commentaries & Views

Panic selling has triggered margin calls in the marketplace over the past week, as investors have finally decided it is time to prepare for the worst-case scenario — a Federal Reserve-induced recession. As suspected in this space last week, the suddenly strong miner and silver relative weakness after a false miner breakout foretold heavy selling in gold this week as well.

The gold price has been sold down aggressively since last Monday to a confluence of support at the $1890-$1900 region. After failing at the key $2000 level for the second time this year two weeks ago, Gold Futures reversed over $100 lower due mostly to the sharp rise in U.S. Treasury yields and the U.S. dollar zooming past the psychological 100 level on the DXY.

These moves have been supported by a steady rise in market expectations of Federal Reserve interest rate hikes and hawkish future monetary policy likely to be announced after the completion of the FOMC meeting next Wednesday.

Before the Fed-speak blackout period began this week, the world’s largest central bank had been uber-hawkish recently with inflation continuing to rise. Central banker jawboning has convinced the market of the Fed-Funds Rate being raised to at least 2.5% by Christmastime, as consumers, businesses and financial markets have largely taken that much tightening in stride.

But with rising rates already forcing yield curve inversions that project an imminent recession, the Fed will eventually have to pull back from its rate-hike campaign to begin filling up the punch bowl again. An "inversion" of the yield curve has preceded every U.S. recession for the past half century. With the U.S. economy already becoming dangerously close to entering recession, commodities have soared across the board as the war in Ukraine rages on and Covid related lockdowns in China create further supply chain issues.

After previous North American government lockdowns forced many to use credit cards to put higher costing food on the table, the over 70% consumer-driven U.S. economy can ill-afford a higher interest rate environment. As interest rates rise, already high credit card rates also rise. And any additional rate increase will make unpaid balance’s balloon, along with inflation already eating up even more consumer income.

Furthermore, signs of coming stagflation into the economy are already being seen in the red-hot U.S. housing market. The conditions that existed during the 1970’s — high inflation and stagnant output — are happening already in this segment of the U.S. economy. Homebuilders are hard at work trying to build new houses to meet demand, but the number of homes actually being completed has been stagnant because of persistent supply chain problems.

The main economic theory of stagflation is that the confluence of a stagnant economy and inflation are results of a poorly constructed economic policy. The recent rise in long-term interest rates has done little yet to improve the inflation outlook and left the central bank at a risky juncture — torn between an even more aggressive pace of rate hikes that may push the economy backwards, or moving too slowly and allowing stagflation to take hold.

Recent soaring commodity prices in the face of a slowing economy and excessive debt levels have placed major central banks in this very difficult position. And when combined with rising inflation, it is likely to lead us into stagflation for the first time since the 1970's.

Over the past four months, the average 30-year fixed mortgage rate has shot up from 3.11% in December to 5.37% as of last week, the MBA survey showed on Wednesday. The rate has not been that high since 2009 when the housing market was grappling with the Great Recession.

If a borrower took out a $400,000 mortgage at a 3.11% rate, they would owe $1,710 per month. At a 5.37% rate, that payment shoots up to $2,148 per month. Mortgage rates have risen 220 basis points from 12 months ago, with most of the rise since the turn of the year as financial markets have reacted to the Fed’s plans to raise interest rates more swiftly.

The U.S. central bank is expected to lift its benchmark interest rate by 50 basis points at its policy meeting next week, and give clues as to how quickly they plan to tighten monetary policy in future. The Fed will also decide when to start cutting its portfolio of $8.5 trillion of U.S. Treasuries and mortgage-backed securities.

The added stimulus (money creation) had helped keep consumer borrowing costs low, for mortgages in particular, until skyrocketing inflation forced the Fed to begin raising interest rates for the first time since late 2018 in March.

On the plus side for gold is an upcoming recession has become more likely and is longer-term bullish for the precious metals sector, while being bearish for the stock market. With equities pricing in growth beginning to slow, the Gold/S&P 500 ratio is back above its 200-day moving average for the first time in 18 months, and has created a bullish inverse head & shoulders bottoming pattern on its weekly chart.

But in the short-term, gold may not be finished selling off after an oversold bounce until stronger support in the $1835-$1850 region has been tested. As I type this missive, an already oversold gold price is attempting hold key support at $1900 into a Comex month-end close later today, while the silver price continues to lag.  

If investors perceive Fed-speak to be uber-hawkish next Wednesday, the gold price could sell down to a stronger support level on its rising 200-day moving average at $1835 before bottoming. This region also coincides with uptrend support from its August 2021 low, along with where its war premium began.

But it is also interesting to note that physical buying in gold ETFs has remained buoyant, and even grown, despite the bear attacks in the paper gold markets having driven the price down triple digits into Comex options expiration on April 26th.

On Thursday, the World Gold Council (WGC) published its report on gold demand trends in the first quarter. The data shows high Q1/2022 gold inflows thanks to strong investment demand, which is set to remain in place for the rest of the year. Global gold demand soared by 34% YoY to 1,234 tons, its highest level since the Q4 of 2018.

Bullion buying was driven solely by strong investment demand, which tripled YoY to 551 tons. This is attributable in turn to the high ETF demand amid the Ukraine war and the steep rise in inflation. With geopolitical uncertainties ramping up each day, coupled with an ongoing high inflation environment, robust gold investment demand should continue as stocks, bonds, and crypto have been revealed as speculative assets — not safe havens.

Meanwhile, the strong support zones in both GDX ($35) and GDXJ ($43) mentioned in this space as key levels to maintain last week have been reached quickly. Both miner ETFs wiped out eight weeks of steady gains after going from overbought, to oversold in just six trading sessions. Although dip buyers and short-covering are being seen with month-end book squaring taking place, caution is still advised in the mining space until the market has priced in next week’s Fed interest rate decision conclusions.

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